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ICOs: how are they defined and regulated?

Updated: Jun 14, 2023

Have you ever wondered how digital currency via ‘coins’ and ‘tokens’ work and are regulated in law? If you play video games and decide to purchase additional, in-game upgrades or enjoy sending gifts to your favourite ‘Tiktokers’ on their live streams - you’re already familiar with the concept of “ICOs”.


How do Initial Coin Offerings (ICOs) work?


ICO issuers accept a crypto asset in exchange for a proprietary ‘coin’ or ‘token’ that relates to a specific firm or project. The digital token issued may represent a share in a firm or a prepayment voucher for future service; or in some cases may offer no discernible value at all. The 2018 Treasury Select Committee Report on crypto assets described ICOs as “a way of raising funds from the public using a crypto asset". Often, projects funded by ICOs are in a very early stage of development or are entirely fictitious.


How are they regulated?


Whether an ICO is regulated depends on how it is structured and what the token subsequently represents:


  • When tokens represent a ‘transferable security’ under the Regulated Activities Order, such as shares and bonds, the ICO will fall within the regulatory perimeter of the FCA.

  • Issuers will thus be subject to the FCA’s Principles and relevant rules.

  • If an ICO falls within the regulatory perimeter, the FCA will also be required to ensure an appropriate degree of protection for ICO investors, as they are considered ‘consumers’ by the FCA.


Are there any complications or exceptions to the rules when using ICOs?


However, when tokens represent a claim on prospective services or products, they do not amount to transferable securities or other regulated products and thus fall outside the regulatory perimeter. Issuers are thus not required to follow the Financial Conduct Authorities principles and relevant rules, and the FCA is not required to ensure an appropriate degree of protection for investors.


Before a ‘transferable security’ is offered (including being listed on an exchange), an FCA prospectus is required, unless an exemption applies. Furthermore, the Financial Services and Marketing Act prohibits, in the course of business, invitations or inducements to engage in investment activity, unless the person authorised or an authorised person approves the communication’s content.

 

For all questions regarding the topics raised in this blog, please contact a member of our team of digital asset legal experts.

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